Optimal Mortgage Reï¬ nancing: A Closed Form Solution

Sumit Agarwal, John Driscoll and David Laibson

Scholarly Articles from Harvard University Department of Economics

Abstract: We derive the ï¬ rst closed-form optimal reï¬ nancing rule: Reï¬ nance when the current mortgage interest rate falls below the original rate by at least \(\frac{1}{ψ}\)[φ + W (− exp (−φ))]. In this formula W(.) is the Lambert W-function, ψ = \(\frac{2 (Ï + λ)}{σ}\), φ = 1 + ψ (Ï + λ)\(\frac{κ/M}{(1 − Ï„ )}\), Ï is the real discount rate, λ is the expected real rate of exogenous mortgage repayment, σ is the standard deviation of the mortgage rate, κ/M is the ratio of the tax-adjusted reï¬ nancing cost and the remaining mortgage value, and Ï„ is the marginal tax rate. This expression is derived by solving a tractable class of reï¬ nancing problems. Our quantitative results closely match those reported by researchers using numerical methods.

Date: 2012
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Published in Journal of Money, Credit, and Banking

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